The relatively strong performance of bank bonds is sending an encouraging signal at a time when financial stocks are under pressure from recession fears.

The KBW Nasdaq Bank Index of large U.S. commercial lenders has slid 11% so far this month, as investors have registered concern about slowing economic growth and falling interest rates, which could pressure banks’ profit margins. The S&P 500, by comparison, has fallen 2.7%

Although the extra yield, or spread, that investors demand to hold bank bonds over U.S. Treasurys has also increased, it hasn’t climbed as much as those on bonds backed by industrial companies.

In fact, the average spread on bank bonds recently fell to 84% of the spread on investment-grade industrial-sector bonds, the lowest level since February 2016, according to Bloomberg Barclays data.

Investors and analysts say bank debt has retained its appeal largely because of postcrisis regulations that have forced banks to hold more loss-absorbing capital and strengthen their balance sheets.

In contrast to where it stood during the last recession, the banking sector is now seen as among the least vulnerable to a crisis if the economy were to slow sharply. That scenario makes investors confident that their bonds will be repaid at maturity.

Adding to the demand for bank bonds this year: Financial institutions have sold relatively few new bonds compared with previous years when they were under greater pressure to issue debt to meet certain regulatory requirements, investors and analysts say.

Through Monday, financial institutions had issued $300 billion of bonds, down 21% from the year-earlier period, according to Dealogic.

Even the negative impact of lower bank profits could ultimately be mitigated for debt investors, some analysts say.

If the economy slows and long-term interest rates stay near historic lows, the Federal Reserve may be less inclined to allow banks to return a hefty share of their profits to shareholders in the form of dividends and stock buybacks, said
Jesse Rosenthal,
head of U.S. financials at the research firm CreditSights. The Fed is expected to make its next determination in June of next year.

There is, in that way, “a kind of natural offset for creditors,” Mr. Rosenthal said.

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Even so, net interest margins—the spread between what banks earn on loans compared with what they pay out for deposits—have narrowed, as long-term U.S. Treasury yields have declined. And many fear those margins could continue to shrink.

Bank shares have broadly declined in recent weeks. Citigroup, for example, has lost 11% this month, while JPMorgan has fallen 7.5%.

Their bonds have fared better. The spread on Citigroup’s 3.980% notes due in 2030 was recently 1.2 percentage points, up just 0.06 percentage points from the end of last month, according to MarketAxess. The spread on JPMorgan’s 3.702% notes due in 2030 has similarly climbed by 0.1 percentage point to 1.10 percentage points.

The “banking sector in general is on a broader upward credit trajectory,” said
Jonathan Duensing,
director of investment grade corporates at Amundi Pioneer.

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Even though bank bonds have outperformed this year, Mr. Duensing said he continues to prefer them to nonfinancial company debt, given his view that some other sectors would be more at risk in a slowdown.

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Lawmakers from both sides of the aisle have introduced proposals to restrict stock buybacks. WSJ’s Ken Brown explains the basics of buybacks and the economics of the plans. Illustration: Laura Kammermann